Deferred tax assets on unrealised losses

Deferred tax assets on unrealised losses

IASB proposals aim to clarify deferred tax treatment for debt instruments under IAS 12.

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The impact will depend on your tax environment and current accounting.

Revised proposals on deferred tax assets on unrealised losses are a welcome step towards addressing the fundamental question of what future taxable profit is. One thing is clear – it is not the bottom line on your tax return.

Our New on the Horizon looks at the key questions raised in the exposure draft, using an illustrative example to explore the IASB's proposed solutions and the impacts these could have on companies.

Can you recognise a deferred tax asset if a loss is unrealised?

Answers to deferred tax questions are not always intuitive. Consider the following.

 

Suppose that you hold a debt instrument that is falling in value, without a corresponding tax deduction. But you know that on the due date you will receive the full nominal amount, and there will be no tax consequences of that repayment.

Do you recognise a deferred tax asset on this unrealised loss?

 

Proposals issued by the IASB in August 2014 attempt to bring clarity to this issue, which emerged during the financial crisis.

The detailed example in the proposals shows that the answer is ‘yes’, if certain conditions are met. This may be the case even if your future bottom line is expected to be a loss.

This may seem contrary to the key requirement that a company recognises deferred tax assets only if it is probable that it will have future taxable profit. This brings us to the underlying question in the proposals ...

What is ‘future taxable profit’ for the recognition test?

Some would argue that the most intuitive answer to this question is the bottom line on the tax return – i.e. taxable income less tax-deductible expenses. However, this is not the IASB’s view.

Our New on the Horizon uses a simplified example to explain the IASB’s proposals and illustrates how they would apply in practice. To summarise, the proposals attempt to clarify how a company should calculate future taxable profit using the following formula.

The example also shows how it is possible for a company to recognise a deferred tax asset despite having an expected loss on its tax return.

Broader implications

The proposals stem from a question about deferred taxes on unrealised losses on debt instruments, but they attempt to address a much broader issue of how to determine future taxable profit for the asset recognition test. Companies will need to consider the broader implications of the proposals.

The impact on your financial statements would depend on your tax environment, how you currently account for deferred taxes, and whether that accounting would need to change.

Expected effective date

With the comment deadline having closed on 18 December 2014, the IASB is currently drafting the amendments to IAS 12 with a view to issuing in December 2015.

On that basis, we expect that the amendment will be effective for annual periods beginning on or after 1 January 2017.

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